Javier Milei is sworn in as the new President of Argentina and delivers his speech to his followers, surrounded by international leaders. Argentine, Buenos Aires on December 10, 2023.

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Milei's bite cannot hold Argentina's hyperinflation at bay

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Photo Credit: Hans Lucas via Reuters Connect/Federico David Gross

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Argentina's new president, Javier Milei, described a country coming apart at its economic seams when he took office on December 10. He called for painful measures needed to restore economic stability. "There's no money," he declared. "I'd rather tell you a painful truth than a comfortable lie." After his convincing electoral victory in October, Milei appears confident that he has a popular mandate to fix the economy no matter the cost. But can he?

Markets seem to think so, at least so far. Investors may be impressed by his vow to seek a fiscal consolidation of 5 percent of GDP—to be implemented, however, by many members of the team of former president Mauricio Macri (2015–19), who was known for his right-of-center gradualism. Among the new president's advisers are Luis Caputo, minister of the economy, a former head of Argentina's central bank, who announced nine critical measures to cut public spending and reform the government, explaining: "The genesis of Argentina's problems has always been the fiscal deficit. Politically, we have always been addicted to fiscal deficits."

Among the steps he outlined were removing price controls imposed under the previous administration, a step the government took immediately; cancelling renewal of public sector labor contracts less than a year old, with the goal of curbing growth in public wages; suspending public sector advertising, which had soared under Alberto Fernández, the previous president; and reducing the number of ministries from 18 to 9 and the number of secretariats from 106 to 54. In addition, he plans a drastic reduction in transfers from the federal government to the provinces, cancellation of all new public infrastructure projects, and a sharp reduction of fuel and transport subsidies, which were dramatically increased during Fernández's administration.

During the election campaign, Milei had notoriously called for "dollarization" of Argentina's currency. Caputo's agenda calls instead for a sizable devaluation of the Argentinean peso, accompanied by an increase in import tariffs and export duties on nonagricultural goods. Instead of abolishing the central bank, he is proposing legislation to prohibit it from financing the fiscal deficit, a practice that has contributed to rising inflation.

Though these measures are dramatic, it is not clear whether they would achieve the goal of reducing the deficit by 5 percent of GDP. More measures may be needed, in which case the ones announced might be followed by another fiscal package in a few months.

The immediate removal of the price controls adopted by the previous administration—the one measure taken so far—coupled with the sharp devaluation of the peso, have already hit people's pockets: In just a few days most supermarket prices have doubled, which will surely aggravate inflation, already at about 144 percent per year, and increase it to 200 percent or above as subsidy reductions take effect. Milei's team and market participants alike seem confident that massive fiscal retrenchment will be sufficient to bring inflation down, though not without much economic pain, notably a significant recession and a rise in unemployment. Are they correct? Probably not, and here's why.

First, Milei's victory was a rejection of the massive spending and regulation approach of Peronism, more specifically the policies of President Cristina Fernández de Kirchner (2007–15) that had prevailed in Argentina during much of the 21st century. Although the population understood that Milei would enact painful economic policies, it is far from clear that they voted for the level of economic suffering that now could last for years, increasing the likelihood of social upheaval, massive demonstrations, and nationwide strikes. Amid such turmoil, Milei's fragile political coalition would likely dissolve.

Second, Milei's supporters are overly confident that Congress will approve his package without significant changes. His economic team faces a hard time selling their ideas to legislators, especially the proposed reduction of transfer payments to provinces. There is a high probability that politics will cut back on the planned fiscal adjustment, resulting in the worst of both worlds: more pain but not enough to accomplish Milei's goals.

Hovering over these considerations is the question of whether the diagnosis of Argentina's problems is correct, or, rather, complete. Is it really "an addiction to fiscal deficits," as the minister of the economy insists, or is there more to the story? The new government and some economists insist that Argentina needs to "avoid hyperinflation." But hyperinflation does not have a scientific definition or cure. Argentina's first significant bout of hyperinflation occurred in 1977, when the country's annual inflation rate hit 300 percent. As mentioned, Argentina's inflation is likely to rise soon to somewhere above 200 percent per year, possibly even 300 percent. Can spiraling hyperinflation be resolved with fiscal adjustment alone? Different countries have had different experiences, but for the two South American countries with some of the worst hyperinflation histories in the region, Argentina and Brazil, the answer is a definitive "no." Argentina could not cure its hyperinflation in the 1970s and 1980s with fiscal adjustments backed by IMF programs and neither could Brazil when confronted with inflation rates of more than 2,000 percent annually between 1985 and 1994.

Hyperinflations of that magnitude will have to be dealt with by introducing a new currency, the subject of a future blog post. Argentina's hyperinflation entails unique problems, including the loss of signaling entailed by relative prices. When prices rise too fast and in a disorderly manner, they cease to signal supply shortages or excesses in demand. Different prices for the same goods can commonly be found in supermarkets and other retail shops. As Milei seeks to get past the current crisis, his policies are likely to spur more chaos. Talk of dollarization will return as a result. Despite Milei's drastic prescriptions, Argentina is unlikely to escape its reckoning with hyperinflation. For now, markets and government alike seem content to ignore that particular inconvenient truth.

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